Are we too heavily -ve geared?

[Ralph]

I'd appreciate some views on the following. We have a heavily (imho) -ve cashflow investment portfolio, about 50k pa before tax, but I think it's justified on the basis of the CG it achieves. How would others run with what we have below, would you look to sell one and go for higher CF properties now, or do you think what we have, while we can continue to service it, is a reasonable setup. Limited info to go on I know, but hopefully some reactions!

We currently have 3 IP's, worth around 1.9mln, and shares of around 250k, total investment debt (inc. on shares etc.) of 1.2mln (50% fixed) and a net investment cashflow obligation of 4k per month before tax, 48kpa.

One IP is worth ca. 1mln and yields 2.2% before costs, actual of 3.4% on debt of 660k. It's in a HDT and we won't sell this as will eventually move into it in around 2 years.

Another is worth ca 600k and yields (on that value) 2.6%. It has debt of 140k and so is 11% yield actual and cf positive, but obviously low yield against market value. It is possible to sell this. Owned 50/50 in my and my wifes names.

Last is worth ca. 270k with yield before costs of 2.9%, actual 3.1% bf costs on debt of 250k. In same HDT as first property. Need to hold this for personal reasons and do expect very good CG on this in next few years, also the potential to split into 3 blocks, sell 2 and hold onto the house.

It's a good CG portfolio, having averaged above 15% pa over the last 5 years. I justify the 50k pa. holding costs to myself on the basis that the CG far outweighs the costs, plan to sell the middle one one day and convert into more CF +ve assets.

Comments highly appreciated.

 

[House_Keeper]

Are the properties in WA? As far as I am aware, Perth is still experiencing good capital growth.

As long as you can afford to hold on to them comfortably, I would hold on to them as long as the local property market produces strong capital growth.

Cheers,

 

[see_change]

One thing missing is your income , and stability of income ( though that's two things... ).

If you're a busy dermatologist , you could afford more negative gearing , but then you wouldn't be asking the question...

The fact that you need to ask the question is a concern for me.

If I was negatively geared to the tune of 50 K , I'd know exactly whether I could afford it. What would happen if rates go up to 9 - 10 % , what would happen if prices didn't go up for the next five years, what would happen if I broke my leg playing over 35 football or my business burnt down....

See Change

 

[WillG]

Hi Ralph,

May I ask how much you earn in your day job ? If you are earning 200 - 300k per year in your day job, this will paint a different picture.

What is the worst case scenario - how many weeks could you last if you couldn't rent your 1mil and/or 600k property. I suspect these properties may be harder to get tennants for than the $270k property. These properties although having the highest potential for CG also hold the highest risk (I'm sure you already know this).

As House_Keeper suggests WA is currently booming, thus CG is looking good.

May I ask what plans you have in the longer term ?

 

[simonjulie]

Hi Ralf
How many days wealthy are you, meaning, how long will your current cashflow last in both best and worst case situations?
What are your escape plans/safety nets if things go belly up?
It seems that you must have used the equity from the past growth to estabish your current position. You may be just adjusting to your new position by the question you asked.
With a LVR of around 65% you still have a little room for buying time or for further portfolio growth depending on your comfort zone, future growth and property choice.
In the life of the investment there are times when the holding costs can be a drain on cashflow but I reckon that the trick to winning in the property game is "Staying in it".
Regards
Simon

 

[Glebe]

Since the yields are poor I wouldn't be expecting much in the way of capital gains for the next 5 years. Happy for you to bring this thread up in 5 years time and prove me wrong.

Don't expect 15% CG growth to last forever.

 

[Glenn]

Hi Ralf,

It seems as though you have done pretty well for yourself already mate!

If I were in your position and I could afford the repayments without it causing pain to the pocket or relationship with my wife and family....I would keep everything you have and sit tight for the next few years.

The only bad stories I hear about property is from people that have sold too early only to see the asset they have sold multiply in value many times in the next boom.

To all those people that think Perth's rise is about to end...when you can make China, India and Brazil stop buying our resources, Perth property will again plateau or fall. In my own highly subjective and 1 eyed opinion, this is not going to happen any time in the next 12 months.

During discussions with 2 agents yesterday, they both confirmed that the inner city has just "gone off" again in the last 2 weeks after a couple of months of stagnation.

Good hunting

Glenn

 

[Ralph]

Thanks for replies

All,

Thanks very much. I did say that I probably hadn't included enough information!, and probably should have led with affordability. I'm comfortable with our ability to cover the payments (see below - but happy to have my logic challenged). Really appreciate the questions, as while I like to think I've covered my bases, a challenge and check from experienced investors is really useful.

So to answer the q's.

2 properties are in Perth, both close to the city. 600k in Inglewood, 600m2 and 1mln in Mt Lawley, 1000m2. Both federation style but VG condition.
Other property is on Raymond Island, near lakes entrance in Victoria. Seeing alot of sea change investment.
They're all doing well for CG, but in any forward projections I always use 6.5% CG as an average long term assumption.

Income is stable, I'm OS at the moment and clear around A 170k a year after tax (rental is paid for by company etc.). Job is stable. I currently derive very little -ve gearing benefit (due to income in OZ only related to these properties and shares), and am accumulating a tax paid surplus for when I come home (not a strategy, just an outcome of investing -ve gear from O/S).

We have half the debt locked in at ca. 7%, for 4 yrs and 9yrs (linked to the 1mln property). Not the best rate, but I am somewhat risk averse and enjoy the sleep at night factor.

If none of the properties rented we would have a bill of 92kpa (int. + costs) at current rates, assuming back in OZ, around 1/2 that after tax. We have around 220k in an offset account and around 250k in shares, so I look upon those as the cash reserves for contingency, followed in the very worst case by selling a property.

I like to think of what we're doing (or at least my escape plans) as reasonably well covered. If these properties weren't growing well (now, or on an expectation basis) then they would be hard to justify. My rationale to date is that I need to see around 50k before tax appreciation to be neutral, or around 2.7% ave CG. This burden reduces over time (1 years CG increases value but not debt etc.). If they do better now or in the future, I'm accumulating wealth at a good rate due to the capital base.

So, long story short, I'm comfortable with the safety net (unless someone blows a hole in it after reading the above ).

Assuming that's fine, what's your thoughts on the strategy. I could sell the 600k now, Perth market is good (house next door sold for 720k a couple of months back after a reno), and chase some units. This would reduce the cashflow burden (assuming I could get a better yield on the units), but not benefit the accumulation of capital (assuming lower CG), and would be selling in a still rising market.

I've been running with a view - in line with your comment Glenn - that while I can make the payments, and am getting growth, it's probably worth hanging in with what we're doing.

Focus of my question was around the above, would you hang on, or would you move to improve the CF. My own view is to do it later.

Thanks again, the advice and challenges are worth their weight in gold!

Cheers,

Ralph

 

[redwing]

At the risk of sounding stupid what is ca???

I agree with Glenn about BIC (Brazil India China) and can see the run in Perth continuing for some time..look at realestate.com.au at the moment or try and vist a home open..

having 4 IP's here I'm happy to see this run continue

REDWING

 

[Glenn]

Assuming that's fine, what's your thoughts on the strategy. I could sell the 600k now, Perth market is good (house next door sold for 720k a couple of months back after a reno), and chase some units. This would reduce the cashflow burden (assuming I could get a better yield on the units), but not benefit the accumulation of capital (assuming lower CG), and would be selling in a still rising market.Ralph

G'day Ralf,

What would it cost you to:

1. Pay an agent to sell a $600k house in Inglewood?? Not much change out of $20k I would think

2. Pay tax on any gains realised from this property?? This may be offset by tax credits built up whilst working overseas?

3. Pay stamp duty on a cashflow positive investment @ $600k?? Does $30k sound feasible?

The point I am trying to make is that it would probably cost you heaps to get out of your current properties and into cashflow positive properties. How would you feel if Inglewood did another 15% next year. What ever you buy in exchange for your Inglewood property would need to increase in value by 25% to provide the same return. Do you have the time to hunt down and create a deal that will provide you a 25% return next year?

It's fine to question things from time to time, we all do. Often, the best thing (although often the most difficult) to do when assessing the portfolio is ABSOLUTELY NOTHING!

The last 2 houses we bought were in Mount Lawley, from experienced investors that were bored with the whole deal and thinking that the Perth market had peaked in 2003.

The gains we have seen over the last 2 years have been quite a humbling experience for us.

Good hunting

Glenn

 

[Oscar]

Ralph, I'm in a similar position to you. My -ve position is ca 40K per annum. Like you I have had massive capital appreciation since buying these few IP's and work o'seas on a good income.

I agree with Glenn's points on costs of selling / buying. At the end of the day for me it comes down to your risk profile. I'm happy to keep wearing this cost for a few years as I know in time when I plan to slow down from full time work in about 10 years that I won't regret hanging on to these excellent blue chip Sydney properties.

In the mean time I'm using my excess income to pay down loans and invest in income producing managed funds, no leverage, but keeps the wealth moving in the right direction.

Good luck with whatever you decide to do.

PS - I think ca., short for circa, is an italian/latin? word for approximately or something similar.

 

[Ralph]

Thanks all for your input.

Yes, ca. is short for circa/approximately.

We had felt that staying put was the right way to go, but nice to get some third party views that line up with that. We'll have another look when we plan to move home in a few years and see how the cashflow works then!

Thanks again for your help.

Cheers,

Ralph